In the Tank: How Oil Prices Threaten Automakers' Profits and Jobs

How Oil Prices Threaten Automakers' Profits and Jobs

Executive Summary

Since the late 1990s, Detroit's three big U.S. automakers -- General Motors Corp., Ford Motor Company, and DaimlerChrysler -- have relied heavily on large, truck-based sport utility vehicles to drive company profits. But with gasoline prices now at near-record highs, consumer demand for mid- and full-size SUVs is sinking fast. What if higher gas prices are here to stay and the trend away from gas-guzzling vehicles continues? To help automakers and policymakers evaluate the consequences of high oil prices, we modeled potential effects of average gasoline prices at $2.86 a gallon ($80 a barrel) and $3.37 a gallon ($100 a barrel) against a baseline of $1.96 a gallon ($45 a barrel). This report says that sales, profits, and American jobs are at risk if Detroit automakers continue with their current business strategy in the face of higher oil prices and recommends actions that automakers, government, and investors can take to mitigate the risks.

Key findings include the following:

Profits at Detroit's Big Three will shrink by $7 billion to $11 billion. Reductions in vehicle sales, especially SUVs, will lead to an industry-wide decline in pretax profits of $11.2 billion to $17.6 billion. Detroit's Big Three will absorb $7 billion to $11 billion in total reductions because of their dependence on SUV and pickup sales.

Detroit's Big Three will absorb nearly 75 percent of the decline in total sales volume. Without deeper discounts, sales volumes in the North American car and light truck market will shrink between 9 and 14 percent, or 1.9 to 3.0 million vehicles, because of the overall effect of higher oil prices on the economy.

Detroit's Big Three automakers absorb nearly 75 percent of the sales decreases. Fourteen U.S. factories, mostly in the Midwest, and two Canadian factories, are at risk for closure and layoffs. Especially vulnerable are GM, Ford, and DaimlerChrysler plants that build mid- and full-size SUVs, large cars, 8-cylinder engines, and rear-wheel drive transmissions in Arlington, TX, Jamesville, WI, Oklahoma City, OK, and Wayne, MI.

At least 297,000 jobs are on the line, 37 percent of them in Michigan, Ohio, and Indiana. North American auto-related employment in 2009 would drop by 9.8 to 15.3 percent if gas prices rise to $2.86 or $3.37 a gallon. Approximately 110,000 of the jobs at risk are in only three states: Michigan, Ohio, and Indiana.

High Oil Prices Are a Key Driver in the U.S. Vehicles Market

In just the first five months of 2005, sales of the Chevrolet Suburban fell by 31 percent, the GMC Yukon by 28 percent, and the Ford Expedition by 22 percent. GM cited falling U.S. SUV sales as the main culprit in its $1.1 billion first-quarter loss; its shares are trading at 12-year lows. Falling sales also contributed to a 38 percent first-quarter profit plunge at Ford, which has seen its U.S. market share decline for 25 consecutive months.

In a bid to prevent sales from decreasing, U.S. automakers have offered steep consumer incentives. In fact, research shows that U.S. automaker incentives between 2001 and 2004 correlate almost exactly to increases in fuel operating costs during the same time.

Although incentives help move inventories of unsold cars and trucks, they also eat into profits, weaken brands, and mask a deeper sales slump. Without these large incentives, both Ford and GM will likely continue to suffer sales declines and lose market share to foreign rivals.

Oil prices have more than doubled since 2001 and have risen to more than $60 by early June 2005. In fact, with almost no spare oil production capacity, it would take only one major event to disrupt world oil supplies, sending prices to $80 per barrel or more. And with geopolitical tensions remaining high in critical oil-producing regions, a supply disruption is a growing possibility.

Automakers, Investors, and Lawmakers Should Act Now

Fortunately, several policy measures could stem these future job losses and declining sales. Automakers, government, and the investment community should come together to address the negative effects of sustained higher oil prices on U.S. automakers in the following ways:

Automakers should make fuel efficiency job number one. Fuel efficiency will increasingly be a key determinant of automaker competitiveness in the near future. Betting on low oil prices might have been a good strategy a decade ago, but today it's a gamble that places companies, workers, investors, and communities at grave risk. Without a product mix that meets changing consumer demand in response to high oil prices, Detroit will pay a heavy toll.

Investors should recognize fuel efficiency's role in protecting shareholder value. Investors can identify, quantify, and, therefore, better manage their risk exposure in the vehicles market if they have more information about fuel efficiency. As with recent investor-led actions on climate change concerns, investors should require greater transparency from U.S. automakers and demand analyses that consider fuel economy.

Lawmakers should raise fuel economy through incentives and standards. Making our economy less vulnerable to high oil prices by reducing oil dependency is a national priority, and it merits public investment and commitment. Financial incentives to retool factories to build more fuel-efficient vehicles would help raise fuel efficiency levels and increase U.S. automaker competitiveness. It is crucial that the states most vulnerable to factory closings and job loss -- Michigan, Ohio and Indiana -- lead efforts to retool the U.S. auto industry.